Italian bond yields hit their highest level in the euro's 11-year lifetime, ominously reaching the same level as Spain's in a sign that Rome is overtaking Madrid as the main focus of investors' concern about debt sustainability.

Italy's stock index fell to its lowest in more than 27 months, dragged down by banks with a heavy exposure to Italian debt. European shares hit a 9-month low amid worries that slowing economic growth will make it even harder to overcome the euro zone's debt troubles.

"The fear of the market is that the world is going into recession again... and in the euro zone the peripheral markets are the ones that will suffer most," said Alessandro Giansanti, strategist at ING in Amsterdam.

Economy Minister Giulio Tremonti called a meeting of the Financial Stability Committee -- made up of representatives of the government, the Bank of Italy, market regulator Consob and insurance authority ISVAP -- a day before Prime Minister Silvio Berlusconi is due to break his silence and address parliament.

Spanish Prime Minister Jose Luis Rodriguez Zapatero, who has called an early general election for November 20, postponed his departure on vacation after the risk premium on his country's debt over benchmark German bonds rose to a euro lifetime high of more than 4.0 percentage points.

Elsewhere in Europe, leading policymakers are on summer holiday after reaching a July 21 summit agreement on a second financial rescue for Greece, the worst hit euro zone debtor, that was meant to buy market peace at least until September.

International bodies offered Italy and Spain verbal support amid the renewed turmoil. The European Commission said both Rome and Madrid were taking necessary action to keep their economies on track and "We are confident in their abilities."

The head of the Organization for Economic Cooperation and Development, a rich nations' intergovernmental think-tank, told Reuters that Italy had its public finances under control and was taking the right decisions to reduce its deficit.

"Therefore it does not need foreign savings to finance its deficits and therefore it is OK," OECD Secretary-General Angel Gurria said in an interview in Athens, noting that Italy had a high domestic savings rate.

POLITICAL INSTABILITY

Italy is in the firing line partly because at 120 percent of economic output it has the highest debt-to-gross-domestic-product ratio of any euro zone nation except Greece, which is nearing 160 percent.

But political instability in Rome's center-right coalition has fueled market concern, with Berlusconi on trial for alleged tax evasion and sexual relations with a minor, and Tremonti under fire over his use of an apartment owned by an aide under investigation for alleged corruption.

The euro zone and the International Monetary Fund have already had to grant bailouts to Greece, Ireland and Portugal. Tiny Cyprus may be next in line due to its banks' exposure to Greek debt, and economic fallout from an explosion last month that destroyed its sole electrical power station.

But Brussels sought to counter reports that Italy may not contribute to the next round of aid for Greece because its own borrowing costs are now well above the 3.5 percent rate at which the money will be lent on to Athens.

"All euro zone member states are committed to paying into the next tranche of aid for Greece," European Commission spokeswoman Chantal Hughes told a news briefing, citing Italy and Spain.

"However, if any country is faced with a higher funding costs at that point in time, when the next tranche of aid would be funded, there is a mechanism in place to ensure that they are compensated for it," she said.

Reuters reported last week that Italy was considering "stepping out" of funding the next Greek tranche or using the compensation mechanism.

U.S. GLOOM WEIGHS

A gloomy U.S. economic outlook, barely relieved by Sunday's deal to raise the U.S. borrowing ceiling, has added to the euro zone's woes.

Investors looking for low-risk assets have piled into German bonds, and British gilt-edged government securities have also rallied, with 10-year yields hitting an all-time low, despite Britain's own uncertain growth prospects.

The OECD said the latest European rescue deal for Greece would only slightly reduce the country's debt and it would take a generation to cut it to more sustainable levels.

However, it said the extra official financial support agreed and maturity extensions for public loans and private sector bonds would give Greece the time needed to implement fundamental fiscal and structural reforms.

"We came here to give a vote of confidence, but we are also here to say we will support the Greek government for a full generation, which is what it is going to take to get those numbers of lower debt-to-GDP," Gurria said.

Many market analysts and economists say the EU deal was insufficient and Greece will need a hard restructuring to halve its debt ratio to about 80 percent of GDP to make it sustainable.

(additional reporting by Ingrid Melander in Athens, William James in London, Sarah Morris in Madrid and Justyna Pawlak in Brussels; writing by Paul Taylor; editing by Janet McBride)

(This story is corrected to make clear in paragraph 1 Italy is Europe's second biggest, not biggest debtor)